My Two Cents - "Kospi Creamed and other fried delicacies"

3/2/2007


This week, the placid complacency of the financial world was shattered by a massive downward plunge led by equities. The swath of damage while small in terms of percentages was large in its breadth. No market was left unscathed; no investor was without that sick feeling in the bottom of his stomach. Since then, the talking heads in the Mainstream Media have scrambled to come up with a sufficiently positive reason why this happened, continuing to ignore the major challenges faced by the economy in favor of the laughable Goldilocks hypothesis.

The following is an overview of Tuesday's carnage:

DJIA(US) -416.02 (3.3%)

SPX(US) -50.33 (3.5%)

NASDAQ(US) -96.66 (3.9%)

NIKKEI(JPN) -917.6 (5.0%)

KOSPI(SK) -74.54 (5.2%)

HANGSENG(HKG) -950.81 (9.6%)

The Shanghai Stock Exchange has been called the epicenter of this fallout, after falling more than 9% during Tuesday's session alone.

If nothing else, this week’s market action should close the case once and for all on the idea that the United States rather than being the engine of global economic growth is merely the engine of the global inflation train. However, there seems to be a breakdown in understanding of how exactly we are exporting our inflation. Let's run through a test-case scenario:

Your family heads down to Best Buy on a Friday evening with the intention of purchasing a new plasma television set. A Japanese model is eventually selected and paid for, let's say at a cost of $2000. Best Buy now needs to replace that particular TV in inventory and orders one from it's supplier, pays the supplier, who then in turn orders one from the manufacturer in Japan. There may be more middlemen, but it really doesn't matter. The point is that eventually the bulk of your $2000 finds its way into a Japanese company's bank account. Unfortunately, the Japanese company cannot do much with the dollars since the local currency is the Yen. The company needs to pay its expenses in Yen. So periodically the company 'goes to the bank' and exchanges the dollars it has accumulated for Yen. Unfortunately, the Bank of Japan doesn't keep enough Yen in reserve to meet all these demands and consequently has to print more to exchange. The end result is that the Bank of Japan is now in possession of an ever-growing amount of US currency. To make matters worse, it has been forced to overprint its own currency so that Japanese businesses are not stuck with all the dollars. The massive infusion of wanton fiat dollars into these foreign economic systems has caused outbreaks of monetary inflation all over the world.

Their inflation manifests itself in exactly the same ways ours does. The price of things goes up. Maybe it is stocks, bonds, commodities, food, consumer expenses, whatever, but that money has to go somewhere. The United States takes advantage of its dollar superiority (hegemony) to force foreigners to accept lower labor rates etc so that prices in this country can be held in check (under 15% growth/year).

What serves to make this phenomenon cyclical in nature is that foreigners have been using their excess dollars to buy our bonds, forcing down yields so that American consumers can borrow money cheaply and repeat the entire cycle. Ok, so how is this a bad thing if you're an American?

Go into a Wal-Mart, Sam's, BJ's or Kmart and find consumer goods that are made here. Find some clothing that is made here. These foreigners realize that we are the parasite and not the other way around. Their countries have benefited from our consumption, but the law of diminishing returns is in full play at this point. The negative affects are spilling over into their economies resulting in stock market bubbles. We saw those bubbles find the pin this week to some degree. The game is almost over. When they cut us off how will we produce the items that we rely on to maintain our rather lofty standards of living? That is where the problem lies.

Foreigners are less likely to take drastic action as long as the status quo is maintained. However, too many more weeks like this past one and instead of seeing the Kospi Creamed, you will get to see a rather large display of other fried delicacies, namely the US dollar, the US consumer, and the American standard of living.

Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. This article and other information is located at http://www.my2centsonline.com Please feel free to distribute, copy or otherwise disseminate this information.